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Banking And Finance Essay

1958 words - 8 pages

Assignment Package 2 (Weight in total marks-20% )
Each of the following question carries 2 marks

From Chapter 6
Q1. What is risk premium? How is it measured? When there is an increase in the default risk on corporate bonds (due to bad economic conditions), what will happen to risk premium. Will it shrink or widen? Why?
(See pages 120-22 3rd edition) (see page 114-115 4th edition)

Default risk occurs when the issuer of a bond is unable or unwilling to make interest payments when promised or pay off the face value when bond matures. This could happen to a corporation suffering high losses due to bad economic conditions. Canadian Government bonds are considered to have no ...view middle of the document...

6% and 0.8%. What are the current interest rates for 2-year, 3-year, 4-year and 5-year bonds?

(See pages 133-36, 3rd edition) (See pages 127-129 4th edition)

Interest rate on 2 year bond
i2t = {(10%+9%)/ 2} + 0.2% = 9.7%
Interest rate on 3 year bond
i3t = {(10%+9%+8%)/ 3} + 0.4% = 9.4%
Interest rate on 4 year bond
i4t = {(10%+9%+8%+7%)/ 4} + 0.6% = 9.1%
Interest rate on 5 year bond
i5t = {(10%+9%+8%+7%+6%)/ 5} + 0.8% = 8.8 %

From Chapter 7

Q3 Match the following.

|(a) Random Walk |(i)future changes in stock prices should, for all practical |
| |purposes, be unpredictable |
|(b) Price bubbles |(ii) Investor expectations are equal to optimal forecasts using |
| |all available information |
|(c)In a Gordon’s dividend growth model(which assumes constant |(iii) If the current price of the stock differs from the present |
|dividend growth in future), |value of the stock’s future expected dividend payments. |
|(d) The current price of |(iv) the stock price depends positively on the expected future |
|a stock share will increase if |growth rate of |
| |dividends and negatively on the expected future rate of return on|
| |stocks. |
|(e)Efficient Markets Hypothesis for financial markets in its |(v) The prices of securities reflect their true fundamental |
|first (i.e., weakest) form |(i.e., intrinsic) values. |
|(f) the Efficient Markets Hypothesis for financial markets in its|(vi) the dividend growth rate, g, increases in the constant |
|third (i.e., stronger) form |dividend growth model . |

Which of the following is not a correct matching pair (answer)

(a, i); - Correct
(b, iii); - Correct
(c, iv); - Correct
(d, vi); - Correct
(e, ii); - Correct
(f, v); - Correct
(c,i ) - Incorrect

Q4. Let’s apply the constant-growth model to IBM. Assume a dividend has just
been paid. The next dividend, to be paid in a year, is forecast at DIV1 = $3, the growth rate of dividends is g = 8 percent, and the discount rate is r = 12 percent.
Solve for the stock value. Hint, Apply generalized dividend(Gordon’s constant growth) model, Select...

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